Microsoft Morphs into a Media Company

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Microsoft Morphs into a Media Company

Mr. Bill makes a billion-dollar bet on interactive entertainment.

__ Just after the spring solstice in March 1994, the anxious staff of the Broadband Media Applications Group at Microsoft Corporation clustered around a conference table in the boardroom of Building 8. They were in the process of their first business strategy presentation to the toughest customer they'd ever face - their boss, the fearless leader of the software world - Bill Gates.__ At the time, Microsoft - still oblivious to the growing significance of the Internet and its emergent publishing medium, the World Wide Web - was focused on a consensual hallucination of magnificent proportions called interactive television. In part to support Microsoft's interactive TV efforts, the tiny media group, only five months old with just over a dozen full-time staff members, was chartered with building the "primal apps" for the company's video-on-demand system, codenamed Tiger. They were developing the key media components for Tiger - user interfaces and interactive program guides - as well as prototypes of a new breed of TV programming and services (one such was an interactive version of Bill Nye the Science Guy.) All this was to be produced by Microsoft, piped to eager consumers over high-speed networks, and delivered through a set-top box also designed by Microsoft. And so the group's executives, many of them fresh recruits from various computer, entertainment, and media companies, spent more than three hours responding to Gates's probing questions. Their hope: that they sounded smart enough to get Gates to free up the US$20 million plus needed to launch the company's most radically un-Microsoft initiative ever. To their dismay, one attendee recalled, halfway through one of the presentations Gates suddenly stood up and said: "Wait a minute - you're talking about TV! Why would I do TV?"

Gates eventually gave the broadband group only half the budget they asked for. But less than two years later, he is "doing TV" in a big way, to the tune of $420 million in joint ventures with NBC News. A string of similar investments both inside and outside the company has led some of Microsoft's top executives to freely acknowledge a notion so antithetical to its culture that it boggles the mind: Microsoft - the $5.9 billion software monolith that literally controls more than 80 percent of the personal computers on the planet, the quintessential nerd palace where stock price and market share are the best revenge - is morphing into a media company for the new millennium.

__ The picture is bigger than you think__

Just three years ago, the response to the statement "Microsoft is becoming a media company" would have been greeted with a derisive laugh. After all, how could a software company, even the all-powerful Microsoft, be successful in the rarified air of storytelling and ideas? And why would it want to bother? But today, the response is far more complex and speaks both to a revolution in the media industries - their wrenching transition from analog to digital - and to the power of the Microsoft hive mind, which throughout the company's history has repeatedly allowed it to quickly learn what it doesn't know and to fix its mistakes as it goes along.

What would a successful 21st-century media company look like? Like its 20th-century predecessors, it would have access to distribution, virtual monopolies in some cases. But onto that foundation it would build deep expertise in interactivity, human interface, and visual computing. It would make its own technology tools and have the ability to define new markets such as virtual worlds. It would also forge major media and hardware alliances using its deep pockets and ubiquitous brand awareness.

Microsoft is by far the only company in technology or media with this combination of assets and strategies in place today.

Though the company continues to assert that software for personal computers is its primary business, over the past two years Microsoft has methodically placed significant amounts of capital, staff, and corporate resources on varied interactive media plays, resulting in a strategy that encompasses everything from the creation of media assets to the invention of next-generation online computing technology.

The best example of Microsoft's growing strategic commitment to media is found not in bits, but in atoms - RedWest, an expensive new Microsoft campus, complete with digital production and design studios that were specially built for the 2,000-employee Interactive Media Division. The division is actively compiling a library of brand-name, mass-market interactive media assets (such as Encarta, the largest selling print or electronic encyclopedia in the world, and Cinemania, a movie guide). In addition, Microsoft is making high-profile investments with large, traditional media and entertainment companies - including DreamWorks SKG, the studio founded by Hollywood moguls Jeffrey Katzenberg, Steven Spielberg, and David Geffen - and forging joint ventures throughout the creative community for new interactive media properties.

The company has also created a new distribution "channel," The Microsoft Network - with 1 million subscribers not even a year after its launch - to aggregate its growing stable of online media properties. It has also lined up interactive distribution deals with companies ranging from national Internet service providers (UUNet) to direct broadcast satellite companies (DirecTV). Over the past few years, Microsoft has also been stockpiling advanced technology assets that target, with surgical precision, each area where the creation and distribution of media are headed, from visual computing to high-speed, interactive digital video.

And while no one knows quite how to go about tapping it, Microsoft sees vast opportunity in interactive media - a business potentially many times the size of the current software market.

As growth in old media such as television, books, movies, and magazines levels off, interactive media is the only realm where analysts are predicting giddy growth rates reminiscent of the early PC business. Unlike big media companies that must find their place in an interactive world without killing their existing cash cows, Microsoft's interactive media successes will continue to strengthen its existing business by further entrenching its Windows operating system as the platform for delivering all kinds of software to personal computers.

Gates has said publicly that by 2000, Microsoft will be spending $250 million per year to promote its efforts via interactive advertising.

Depending on how you tote it up, Microsoft's commitment to these projects over the next five years could range from $800 million to $1.5 billion. That's serious money, even by Disney or Viacom standards.

By these measures, the point of whether or not Microsoft is becoming a media company is too obvious to debate. "Yes, we are becoming a media company," says Nathan Myhrvold, Microsoft's former VP of the Advanced Technology Division, now group vice president of Applications and Content. Other top executives, who are in the process of making it a reality, also bluntly assert the point. "We're more firmly on the path now than we've ever been," says Patty Stonesifer, the senior vice president who runs the Interactive Media Division.

But the irascible Gates, who signs off on all but the smallest of Microsoft's deals, is aggressively dismissive of this notion. He says the media business is too competitive and fragmented for Microsoft to want to be a player, and he scoffs at the notion that its media investments or revenues will match its $3.6 billion applications business "in my lifetime." Gates says his company's lengthy list of commitments to date are "experiments," nothing more, and that the size of its investments isn't noteworthy because, "Well, we've never been capital constrained."

Given what's in process at Microsoft, Gates's naysaying is largely ceremonial. He can coyly argue that he has no overarching vision in this area. But no matter what he says, a strategy is unfolding - one that creates, by design or by cautious covering of bets, the outline of a 21st century media company.

__ Morphing media into the 21st century__

Since Microsoft is making big, high-profile financial commitments to growing its media business, why is Gates putting his money where his mouth is not? If taken at his word, what does the company hope to gain from dipping its big toe into the media pool?

Gates certainly doesn't want to spook his shareholders into thinking that he's moving out of the high-margin, high-profit software safety zone that the company owns lock, stock, and barrel, and into the more risky, expensive, hits-driven media business. If investors and the financial markets believe Gates is investing too heavily in media, Microsoft's high fiying stock could take a hit. At the moment, software companies are generally valued at much higher multiples of earnings than are media companies. While Microsoft's market capitalization is about $61 billion on $5.9 billion of revenues, Disney's $12 billion revenues (pre-ABC) are valued at only $44 billion.

Surely, Microsoft will be selling plenty of PC software longer than many people care to think about. But if Microsoft intends to transcend its dominant but limited position as a PC software company, it needs to evolve. And interactive media, a market that Microsoft pioneered in 1986 and has championed ever since, is an obvious focal point for the PC software giant.

The total PC software industry, in which Microsoft is already the largest player, pulls in some $27 billion in annual revenues at best, while the media business - including film, television, music, home video, and print publishing - earns close to $200 billion, and that doesn't include the mammoth telecom business. Despite its fairly steady 20 to 25 percent profit margins, the software industry is relatively finite; once PC owners have purchased their suite of application software (word-processors, spreadsheets, databases), they generally don't spend much more except to buy upgraded versions of what they already use.

But media is a renewable resource for which consumers steadily spend money every month, and increasingly it is a product that is created by and for computers.

Over the past decade in particular, virtually all traditional media companies have made the switch to digital tools - computers and software - to create their books, films, and music. At the same time, cheaper and more powerful PCs and software yielded a new combination of technology and media that allowed PC users to click around on their computer screens and drive their own private interactive experience - comprised of digital pictures, sound, and text that could be stored on a CD-ROM.

For the first time, a single device - the personal computer - could be used to create, distribute, and consume a media product. This spawned a new media genre, interactive media or "mediaware," which has extended its reach far past CD-ROMs onto the World Wide Web.

__ Fleeter than the lumbering giants?__

But despite an enormous amount of hype about interactivity, consumer acceptance has been slow - at least in proportion to the hundreds of millions of dollars invested in mediaware over the past few years. While the technology of interactive media first sprang from the loins of the computer industry - specifically, Microsoft and Apple - everyone assumed that nerds could never make mediaware compelling to consumers. As soon as the real media companies got involved, went the common wisdom, the market would skyrocket.

Instead of launching a big new market, big old media companies found that, for the most part, they didn't understand how interactive technology could improve their existing products or spawn new ones. Most are still using CD-ROMs, the Web, or both as a way to wring a few more cents out of their existing titles or publications, and as a result they are trapped between moving wholeheartedly into a new medium and cannibalizing the market for their existing, moneymaking products.

Thus, as the wise are discovering, 20th-century media companies don't automatically get a place in the queue. Norman Pearlstine, the former executive editor of The Wall Street Journal who is now editor in chief of Time Warner, says that "successful new media will come only when you have at least one of three elements - timeliness, specificity or personalization, and a transaction - and if you have all three, so much the better.

"Information and money at some point become fungible," Pearlstine adds. "It is an interesting question whether financial institutions, say, can't more easily add information to what they do than information companies can add transaction capabilities. I can imagine a Citicorp having an automatic teller that prints out headlines and coupons every time I use it. Given how long it takes technology to become useful, how dumb is it to invest in things that may finally make some sense around 2010?"

Microsoft's answer would be, "Not dumb at all." In combination with Gates's long-stated goal of "a PC on every desk and in every home," Microsoft clearly hopes to capitalize upon Pearlstine's point of view, based on the sheer breadth and foresight of the media investments the company is making today.

__ Tallying "dollars spent per PC"__

Microsoft claims its interest in the media business is solely focused on interactive media, a PC-based market that Microsoft has steadfastly championed since the mid-1980s. For now, at least, the PC-based media is a tiny niche compared with classical content delivered by media giants like Disney, Time Warner, and Viacom. Myhrvold says Microsoft is "explicitly not" going to become a player in the movie business and "certainly not" in the TV production business. And, he thinks magazines and most print publishing have sufficiently fiat growth that they won't start Microsoft's digestive juices fiowing.

What does get those juices fiowing is the idea of selling software into every nook and cranny of the computing environment. Microsoft is legend for its single-minded focus and ability to leverage - with a crowbar if necessary - its dominance of the desktop PC market, starting in the office and now in the home.

The key to Microsoft's success in the software business is that it has linked its operating system, Windows, to its productivity applications, tools, and network servers in a tight, interdependent chain. Since Windows is the market leader - so strong that the Chinese government has actually declared it the official operating system of China - anyone in the chain (from applications developers to hardware manufacturers and, increasingly, networked back-office systems) must continue to tie its product development plans to Microsoft's to remain relevant in the market.

And because the company completely dominates the market, with Windows as the runaway de facto standard, Microsoft has the luxury of measuring its growth and success by what Gates and his lieutenants call "dollars spent per PC." Having already cornered the market for PC software applications, Microsoft's march into the interactive media world presents an intriguing opportunity. Sure, today's consumers go to the theater, rent movies, buy music, watch TV, and subscribe to magazines and newspapers, but a lot of them also play videogames, and some even buy CD-ROMs.

Perhaps most important, millions are paying from $10 to $200 or more a month - depending on their addiction level - to hang out online, most are using their Windows PCs and, increasingly, the Internet to get there.

__ The content club__

The online trend fits nicely into Microsoft's dollars-spent-per-PC formula, and clearly was the genesis for the company to build The Microsoft Network. Though no one there comes right out and says it, MSN was, and still is, the fulcrum of Microsoft's media strategy.

MSN was to be a no-brainer for Microsoft. Owning the Windows franchise - some 20 million copies of Windows 95 have been sold since the August 1995 launch and 100 million Windows 3.1 users are still fence-sitting - means Microsoft has a mind-boggling potential customer base for just about anything it wants to ship with its Windows software. Eyeing online as the vanguard of interactive media's next generation, Microsoft built MSN, a proprietary online service and - creating serious agita for competitors such as America Online, CompuServe, and Prodigy - announced that it would put the MSN registration icon on every Windows 95 desktop.

The competing services were beside themselves about the unfair advantage they believed the desktop MSN registration icon represented, even going so faras to unsuccessfully petition the Justice Department to block the release of Windows 95. But Gates says Microsoft's surveys showed that "most users didn't even know the icon was there." So how did it sign up a million people in less than a year? "Through the Windows installation procedure," says Gates, with a sly smile. (This March, AOL signed an agreement to include Microsoft's Internet Explorer browser with its own online software in exchange for Microsoft placing AOL's sign-up icon inside a folder on the Windows desktop. You decide who won that round.)

Back in August 1995, Microsoft believed that if only a fraction of its new Windows 95 customers signed up for MSN, it would quickly achieve a critical mass of subscribers and leave AOL, the market leader, eating its bits. Microsoft thought this critical mass would be a magnet to content companies looking for a better deal. Most paid an exorbitant portion of their online revenues - usually 85 percent - to AOL; in its first iteration, MSN was going to collect about 30 percent. But, for whatever reason, not much in the way of compelling content fiocked to MSN. And 10 months after launch, even with a million subscribers, MSN barely met the company's most conservative internal projections. It was not the AOL killer for which Microsoft had hoped.

__ Bill gets caught by surprise__

Then came the Internet. Last year's high-profile success of the Internet and the Web, which were genetically coded to be agnostic about operating systems, threatened not only the relevance of proprietary online services such as AOL and MSN but also Microsoft's entire model of market dominance. If Microsoft could not find a way to surgically insert the Internet into its operating system/value chain model, its enormous business might slowly be bled away by competitors who considered the Internet, not Windows, to be the platform for which they created and distributed their software.

This realization spawned Microsoft's Internet strategy, a complete corporate about-face announced in December 1995. "Here's a company less than 20 years old that decided to reinvent itself last year," says DreamWorks co-founder Jeffrey Katzenberg, who had been working with Microsoft for nearly a year when the Internet strategy was announced. "I've never seen or heard of it before - anywhere in corporate America - where a company at the pinnacle of its success decided to completely, overnight, cause a revolution in its strategic future."

This strategic revolution meant building Internet access into Microsoft's entire existing suite of products, from applications to tools to servers. If the strategy is widely adopted throughout the industry, Microsoft's browser, Internet Explorer, may disappear from view entirely, sucked into the existing interdependent chain of operating systems, applications, and servers. Outlined in detail at Microsoft's Professional Developers Conference last March, the company's plans are so comprehensive that one developer who attended said, amazed, "They really are going to own the world."

But even if you own the world, how do you build the global Internet into a proprietary online service like MSN? Gateways to the Internet already installed by existing online services (such as AOL) make the Web clunky and slow. So in a move clearly born of necessity, Microsoft decided to blow the doors off MSN; it announced early this year that it will shut down the proprietary version of MSN at some point and transition it directly to the Web's nonproprietary HTML standards.

Will the new MSN strategy work? No one knows. How to make real money on anything having to do with consumer interactive media, especially on the Web, remains a mystery to the industry at large. As Stonesifer says, "We don't kid ourselves that we know what's going to happen. If someone told me they did know, I'd say Sign 'em up."

But this much is for sure: if it does work, Microsoft is positioned for a big win. With its Web-based MSN service, the company is trying to create a new business model - essentially, a distribution "channel" for mediaware that it calls "the content club." Laura Jennings, an eight-year Microsoft veteran engineer with an MBA who was recently named vice president of MSN in yet another media division shake-up, says the content club is a kind of hybrid record club/cable service. In the same way that customers can now choose a selection of TV programming from their cable services, MSN members will be able to select their own mix of Web programming.

Jennings says that the company hasn't set pricing yet, but that bare-bones MSN is likely to be free, and like network TV, will be wholly subsidized by advertising. There will likely be a monthly subscription charge for premium-tier service. "And with some products, we'll feel that we need to put a lot of marketing money behind them so we'll offer them à la carte," she adds.

This model is a counterculture move for Microsoft, which is being forced to do something it has never had to do before: act like a broadcaster and fill its channel with interactive media that it believes will drive consumers to the MSN channel. (This "channel" strategy, by the way, becomes a movable feast in the context of both Internet via cable modem and interactive television, should either ever materialize.)

"They're being forced to program the Net," says Vortex Communications partner Mark Benerofe, a former CNN executive producer and former Microsoft employee who participated in the early planning phases of the company's media strategy. "This is a new skill set for the company - doing programming means it'll have to learn how to manage creatives, set up an advertising sales force, and do retention marketing" to hold onto customers once they've signed up for the service.

But because the Web is an open publishing platform and not a proprietary online service, Microsoft must be more than its elephantine self to attract quality content to MSN. As a result, deals for content providers have changed dramatically, with Microsoft acting as the bank for most of the online content development deals it is pursuing.

David Witus, director of business development for MSN, says Microsoft has abandoned the boilerplate, take-it-or-leave-it contracts of the proprietary MSN days. Today, the former Hollywood entertainment attorney says, Microsoft's business involvement with its MSN content partners might range from fully funding a project in exchange for equity participation rather than ownership, to paying a content partner an advance against either royalties or advertising revenue. The most gossamer business connection is the $1,500-per-month link fee that Witus says content providers will have to pay to link their sites from the Web at large to MSN.

Advertising and other kinds of program sponsorship will provide the bulk of MSN's cash fiow and underwrite the basic service. Witus believes MSN will create value for advertisers in much the same way that a TV channel does: by packaging programming - in this case, Web sites - within the MSN brand and by selling its demographics. "We don't want 50 content providers in 50 areas talking to 50 advertisers," Witus says. "It's better if the broadcaster owns the model." Sounds familiar.

__ The strategy morphs, too__

The exact date that Microsoft will fiip the switch from today's proprietary MSN to Web-MSN hasn't yet been announced, though it's expected to be toward the end of 1996. But with a business model that's in fiux and a variety of ways to fan a revenue spark - if ever one catches on the Web - Microsoft is covering its bets in virtually all forms of interactive media and reconfiguring its strategy as it goes along.

For example, Stonesifer says that Microsoft's CD-ROM product line is in the process of dramatic change. At the moment, there are almost 75 CD ROM media products available in the Microsoft Home portfolio, from Julia Child: Home Cooking With Master Chefs to Microsoft Dogs and The Ultimate Frank Lloyd Wright: America's Architect.

But don't expect to have Julia or the dogs to kick around much longer, nor a number of other high-profile, special-interest publishers such as Readers Digest, the Voyager Company, WGBH, and Dorling Kindersley. Though they were courted and signed up to produce interactive media titles for Microsoft early on, only a few of these partnerships are currently active, and products of such narrow interest will no longer be added to Microsoft's product line.

__ Niche doesn't make Bill rich__

Though Stonesifer claims that "quite a few" of the titles are profitable, she says it's a question of "opportunity cost" - in other words, they require too much work for too small a return. "We have big engines that need to be fueled here. If you do everything right and the stars align, on a gardening title you can make $5 to 10 million," says Stonesifer, sounding a refrain familiar to any big media company executive. "But $5 million is a very small number per home PC. Just the sheer dollars per title caused us to say, Let's do fewer and go further with them."

Virtually all the projects in Stonesifer's division refiect this new philosophy. Encarta, Microsoft's most profitable title, will be regularly updated via MSN and has become the fulcrum for ancillary products such as online events and special versions for teachers. Cinemania and Music Central, a music guide, both include online updates with the purchase price.

In addition, Microsoft now owns the technology to build a line of simulation videogames, beyond its popular Flight Simulator title, and has hired a cartography team to map the entire globe electronically. Its online-only products - including a decision guide for buying cars, a health information database, and a 3-D service called V-Chat where chatters are represented by avatars in a virtual 3-D world - also appeal to a more universal audience. MSN's Jennings is commissioning outside producers for entertainment products with broad appeal, including "cybersoaps," and is building a team to deliver entertainment listings on a city-by-city basis, a first step toward creating regional editions of MSN.

Even more critical to the company's success are joint ventures with large, traditional media companies that have businesses that match Microsoft's sense of scale, according to Peter Neupert, the vice president of strategic partnerships for the Interactive Media Division who has negotiated virtually all of Microsoft's media deals. Strong brands, he says, can pull new users into MSN; big-name partners also bring assets and expertise to Microsoft that the company does not have, and vice versa.

__ The PC becomes the TV__

For this reason, MSNBC Online, the joint venture, may be particularly interesting to watch, since NBC is bringing to the venture a formidable set of video assets for the next generation of online services. "Any partnerships we're establishing now, we're looking at video assets," says Jennings, who warns against writing off interactive TV permanently. "TV tuners will start being shipped in PCs by the end of 1996. For a bunch of reasons, 1997 is when we'll start to deploy video in any common way in online services - it'll be pervasive by 1998 or '99." Microsoft is doing its part by championing its own line of low-cost living room computers called the SIPC - Simply Interactive PC.

Of course, such partnerships are risky in many ways. What happens if one company decides it wants to be in the other's business? For example, where does MSN draw the line between the news it produces with MSNBC Online and its local coverage?

With the changes that electronic delivery has already wreaked upon the world's newsrooms, NBC was compelled to move ahead despite that particular risk. "Everyone's trying to define or redefine how you get at the editorial process, at the production of content online," says Andrew Lack, president of NBC News. "You could go it alone, but the reason we wanted to get together with Microsoft is we have some appreciation of each other's talents. I don't believe anyone's actually created programming for television with an understanding of how it might be applied in the online world. I have huge changes to make in my culture here, in this organization, to make this happen."

And how about when the companies are competing in virtually the same market, as are DreamWorks Interactive and Microsoft by making PC-based CD-ROM and game titles for kids and adults?

"It's not possible for us to consider them a competitor and not a partner," says Katzenberg. "We are a great test bed for a lot of the things that Microsoft is developing today, and a great showcase. Based on everything I've seen in the last year, I suspect its first instinct would be to figure out how we could do something together, should the company's ambitions get bigger in the world of media creation."

Although this response doesn't exactly play to form for the market-hungry Microsoft, collective wisdom is that the media business is making the company a kinder, gentler partner. "They're just so much nicer now," sounds a familiar refrain from business partners. In any case, the sheer weight of NBC's news savvy and DreamWorks's collective talent will certainly make Katzenberg's statement true for the foreseeable future. But even if Microsoft's partnerships eventually fail or implode or in some other way cannibalize themselves, some people think these types of ventures are the only way for companies to cover their bets until the real new-media industry emerges.

"Joint ventures are the places where new cultures will be born," says Steve Arnold, who was head of Microsoft's Broadband Media Applications Group before joining a venture capital firm last year. "It's a complex transition - to figure out how you combine technology and media so the product is the best of both worlds, rather than something that's smushed in between."

__ Cutting into the cultural safety zone__

Anyone plunging into interactive media today is putting a happy face on the risks involved - except for Gates, of course, who continues to sound the dour note. But clearly the kind of transition that Arnold describes has all the big information, entertainment, and technology companies thinking big thoughts about their futures. "Anybody who has built a business of scale needs to do anything they can to protect it," Time Warner's Pearlstine says of Microsoft's sizing up the media business. "I think the hard thing for Gates is that he doesn't understand content much more than any of the content people understand technology."

But, he adds, Gates seems "more willing than most" to figure out what customers want and give it to them, "even if it means cutting into the safe margins he's built."

If true, proving that willingness over the long haul may be the toughest challenge that Microsoft has faced. Its media strategy must cut into its safety zone not just economically, but culturally. Media - even the news - is about imagination and emotion, and often it is about singular vision. Good software code alone does not guarantee a hit product, any more than a good camera guarantees a blockbuster movie.

One successful videogame developer remembers being wooed as a potential acquisition by Microsoft some time back. "They kept wanting to look at the code," he recalls. "I kept saying, Forget the code! The code is meaningless! Look at the creative process, that's what's important!" This is, in fact, one of the most important lessons for Microsoft to learn: great media is often created in a collaborative environment, but it cannot be done by committee - a painful fact Gates learned firsthand after seeing his book, The Road Ahead, almost universally panned for having been put through the corporate "blander" and not sounding Gates's own authoritative, querulous voice.

A corporate commitment to change on such a fundamental level may be more difficult than anyone at Microsoft can imagine today. The Microsoft executives most closely aligned with its media strategy believe that the interactive media business is not only unproven but untapped; other top executives at Microsoft may already be balking at spending so much money on what is clearly a far riskier, or at least less profitable, proposition than defending their stronghold in PC software.

Above all, Microsoft is a company that makes its way in the world based on financial strength - so much so that every employee has real-time access to Microsoft's stock price over the corporate network. Anything that might push down the company's stock price or valuation is considered anathema.

Though Microsoft is definitely a long-term player when it comes to technology investments, most of the company doesn't know and couldn't care less about the media business.

As a result, some company employees believe that Microsoft's recent reorganization, which pulled all its media products and projects into a single unit, Stonesifer's Interactive Media Division, was a clear sign that the corporate powers-that-be were getting impatient to see some cash return on their sizable investments.

Before the reorganization, what was called the Consumer Division was financed primarily by one of Microsoft's most lucrative products, the small but mighty Microsoft Mouse, which by one estimate accounted for between $23 million and $34 million in revenue in 1995. (Microsoft would not disclose exact figures.) After the reorganization, the mouse was removed to the Input Device Group. "The mouse business kept us afioat," says one employee of the Consumer Division who works at the elaborate new RedWest campus. "Now they've put all the money-losing things in one place. We're hearing that they want the business to make 20 percent margins before infrastructure costs. The waterfall alone on the new campus would eat that up."

The consumer division's financial performance won't be easy for Microsoft watchers to track. Even though the media business is separated in Microsoft's internal structure, publicly it is grouped with the company's highest revenue generator, its desktop applications business under Myhrvold's Applications and Content Group.

__ Bringing media culture to BOOP__

Even if the Interactive Media Division hits the 20 percent mark, compared with the 5.9 billion in revenues brought in by the applications and operating systems groups, interactive media will remain a small business for Microsoft for the short term. But if current levels of investment in media continue or increase, the company will eventually have to acknowledge that media is one of Microsoft's strategic businesses. Gates may have to bring a real media person into BOOP - Bill's Office of the President - so that the tenets of media culture can start to pervade the company as thoroughly as the hive-mind programmers' culture that has reigned for more than a decade.

Gates himself is not one of the customers he hopes to attract - a busy guy, he has been heard to say that his regular media consumption includes CNN and The Economist, and not much more. Instead, Microsoft's budding media culture is championed within BOOP by Myhrvold, a physicist by training who has also been busy over the past decade building Microsoft's technical prowess by leading the company's Advanced Technology Division. (See "The Physicist," Wired 3.09, page 152.) Stonesifer, who has held a variety of senior positions at Microsoft, including a stint as the general manager of Microsoft Canada, has only tenuous connections to the media business - she was a senior executive at a technical publishing company before coming to Redmond almost a decade ago. And Neupert, despite the high esteem in which he's held by the publishing and entertainment communities in New York and Hollywood, has experience mostly in business strategy and project management.

Though clearly everyone from Myhrvold on down the org chart is reaching deep into the creative community for both staff and deals, things may reach a point where their best efforts aren't enough to move the business forward. "The thing that never changes at Microsoft is the upper levels," says one former employee about the Microsoft veterans who run the media group. "All the real media people are outside of those inner membranes."

Inserting at the highest possible level a seasoned, lives-and-breathes media executive becomes increasingly important for a couple of reasons. First, such a person will be critical if Microsoft wants to attract and hold onto creative talent. In March, when this story was written, Michael Kinsley - one of Microsoft's only true media stars who left a job on CNN's Crossfire to start a magazine for MSN - had not yet met either Gates or Myhrvold, a situation that would be considered a grave faux pas in a real media company. Second, when the big joint ventures get down the road a piece and are still hemorrhaging red ink (as they almost certainly will be), someone with sufficient knowledge and authority will need to be around to remind Gates and his fellow executives that media is the polar opposite of the shrink-wrap-and-ship software business. It is an annuity, driven by hits and subscription renewals, that builds value over time.

But who knows? With all the old-world rules in fiux, maybe bringing media people into BOOP won't matter. Maybe in the same way that Microsoft is morphing itself into a media company for the next millennium, Gates and Myhrvold et alia are morphing themselves into 21st-century media executives. If you consider the measure of dollars spent per PC to be roughly analogous to the concept of a subscription - an annuity - then Gates himself has already taken to describing Microsoft's applications and operating systems businesses in the language of a media company. The executives in Stonesifer's Interactive Media Division don't kid themselves into thinking they're media folks and are hanging tough with the uncertainty of having people around who they don't understand and who don't understand them. "Every meeting around here is a mystery these days," Stonesifer laughs.

Despite the fact that no one seems to be making money on it yet, and despite the rampant mediocrity of the products in the market today, the good news for Microsoft and other players is that there does seem to be something compelling overall about interactive media. Kinsley wasn't exactly a propellerhead when he moved to Redmond in December 1995. The telephone, not email, was his primary mode of electronic communication. Attracted first by the offer to run his own magazine and by the economies of publishing on the Web, Kinsley recalls that "the glitzy stuff, links and all that" were lowest on his list of priorities. "But I will say this - having gotten here, you get excited about the whiz-bang stuff in spite of yourself," Kinsley says. "The original idea of just publishing a magazine only never printing it - well, that's ancient history."

__ What will success look like?__

Microsoft executives generally brandish garlic and crucifixes when asked to visualize what their future will look like 5 or 10 years down the road. Asked about the new media business, besides the occasional, dyspeptic "Do the math!" comment, Gates will only say, "No guarantees. Microsoft is the company that will never make any forecasts. We don't promote our future. We may fail!"

Stonesifer won't say much more. "We certainly think interactive media is a good business, and if we attract consumers, this could be a very big business - and for Microsoft, that is a very big number. The economies will become more clear over the next 18 months. Of course there are projections," she adds, "but they're what ifs, and of course I'm not going to tell you what they are."

Eighteen months sounds about right: another one or two Christmas seasons will make or break most of the CD-ROM companies that are struggling mightily today, and many of today's big Internet investments, experiments such as @Home and Pathfinder, public offerings like Yahoo!, and the viability of advertising on the Web will by then manifest signs one way or the other, boom or bust.

But the success of Microsoft's media business has as much to do with what happens inside the company over the next 18 months as what unfolds in the market at large. Analysts are already predicting that the company's new Internet strategy will pump up its core applications business to new heights and encourage some of the 100 million slacker Win 3.1 users to upgrade to Win 95 or the next-generation system, Windows NT. So there's no reason to believe the company's overall steady growth will slow in the short term, and since Microsoft has gone on the record repeatedly as a long-haul player, it's unlikely that cash will cease fiowing to the RedWest campus anytime soon.

What remains unanswered is whether any of Microsoft's current new media business models (say for CD-ROM or MSN) will hit pay dirt. And always a wild card is what new technology might roll out of some 27 year-old's garage and onto the Net, making obsolete whatever has come before. Katzenberg says that trying to guess where the industry is headed "would be like calling a baseball game in the fourth inning."

But when it comes to this particular baseball game, the bases are already loaded.

Microsoft has more disposable income to play with than almost any other company experimenting with new media. It has placed bets in every possible category - from high-profile partnerships with existing media companies to extensive development of internal media properties - and has the time to wait and see which will hit pay dirt.

Microsoft also doesn't have to worry about new media cannibalizing its existing audiences or advertisers - a significant hurdle for old media companies. It has virtually all technology bases covered, from today's Internet to more futuristic stuff such as visual computing, which will surely be built into PCs, system software, and new consumer products as soon as feasible and marketable. In fact, with the PC as delivery vehicle, anything Microsoft can do successfully in this world improves its existing businesses.

While many are concerned that Microsoft may be incapable of embracing media culture, others working with the media group have a bit more faith, especially in light of Microsoft's impressive historical willingness to make incremental improvements on the fiy in its products and strategies. "Microsoft is a learning company," says Linda Stone, who oversees the V Chat group. "The culture here is already changing. I have no doubt that they will learn whatever they need to be successful."

So, whether by design or by circumstance, Microsoft is holding all known pieces to a puzzle that could snap together into a new breed of media company, a "technomedia" company that not only creates media but also controls the entire value chain of delivering it - PC software, Internet access, servers, and creative tools. And it has the market clout to keep trying until something, or maybe even everything, clicks into place.

__ Smells Like 21st Century Media__

It would have access to distribution, deep expertise in interactivity, human interface, and visual computing.

It would make its own technology tools and have the ability to define vitual worlds.

ould have major media and hardware alliances, deep pockets, and ubiquitous brand awareness.

And in many areas, it owuld have a major head start on the competition... Microsoft's extensive reach into the interactive media business could well make it the world's first 21st-century media company. Here is a partial list of the company's projects, ranging from partnerships and joint ventures to internally developed products, acquisitions, and distribution deals.

Media Content:

€ CarSource: a Web-only decision-making guide for car buyers using Intelliquest data, was scheduled to début on the Internet in May.

€ Cinemania: An interactive movie guide, Cinemania also includes an MSN component that refreshes the CD-ROM version with new movies and reviews from Leonard Maltin, Roger Ebert, and former Los Angeles Times film critic Sheila Benson.

€ Cityscape: This internal project is looking for local partners to provide comprehensive online listings of events in various cities throughout the US; it will hire as many as 100 people to launch this nationwide effort.

€ Corbis Corp.: Though not a Microsoft investment per se, Gates owns (and Microsoft is a customer of) this rapidly growing archive of more than 700,000 digital images. Corbis owns the world-famous Bettmann Archives and recently signed an exclusive digital rights licensing deal with the Ansel Adams trust.

€ Encarta: Users of Microsoft's multimedia encyclopedia can sign up for updates that will be regularly available via MSN. Ancillary products include Encarta on the Record, a live, online event hosted by journalist Linda Ellerbee, and a Web site for teachers called The Encarta Schoolhouse. Microsoft is spending an unconfirmed US$30 million to "localize" Encarta for other countries, changing its editorial content to reflect different cultures.

€ Health: This online title will include 400 illustrated articles and a database for helping diagnose childhood ailments by symptom and will preview on the Web in May.

€ Interactive advertising: By 2000, according to Bill Gates, Microsoft will be spending $250 million per year in interactive advertising.

€ Michael Kinsley: The former editor of The New Republic and formerly the wide-eyed liberal co-host on CNN's Crossfire, Kinsley moved to Redmond to launch a Web-based magazine on politics and culture.

€ Music Central: One of Microsoft's newer products, Music Central ships on CD-ROM and is updated regularly online. It lists more than 80,000 music titles, as well as reviews, artist biographies, and music clips from various musical genres.

€ MSNBC: NBC and Microsoft will together invest $420 million over five years to build MSNBC Cable - a 24-hour TV news service to compete with Cable News Network - and MSNBC Online, an interactive, Web-based news and information service.

€ DreamWorks SKG: Microsoft owns a small equity stake in DreamWorks; the two companies also formed a $30 million joint venture, DreamWorks Interactive, to create games for PCs and game machines. A handful of titles - including one based on the popular Goosebumps video and book series for kids, published by Scholastic Inc. - should be ready in time for the 1996 holiday season.

€ R/GA Digital Studios: Microsoft has signed a multititle deal with this highly regarded, New York-based digital media creator of special effects, advertising, and interactive media for event-driven entertainment programming on MSN.

€ Black Entertainment Television: Microsoft formed a joint venture with BET for a series of products including Web programming, CD-ROMs, and interactive TV.

€ Paramount Television Group: Microsoft has signed Paramount to create three interactive entertainment properties exclusively for MSN, including one based on Star Trek.

€ Gauthier & Gilden Inc.: This New York-based company, which wrote a popular interactive soap opera for America Online, is now working on a series of "cybersoaps" exclusively for MSN.

€ Maps: Microsoft hired a cartography team to map the globe and provide interactive linkages for its growing line of reference products.

Media Technology

€ Advanced Media Technology: Microsoft has been gradually creating or acquiring crucial pieces of media technology, which alone or in combination with others have the potential to spawn powerful new forms of media. Softimage 3-D animation and product tools now being ported to the PC, for example, in combination with the avatar-based V-Chat system for MSN, could launch a new generation of online entertainment. Microsoft's Internet browser married to a "social interface" like Microsoft Bob, designed to make using computers easy for novices, could become a compelling way for future consumers to navigate the Net. And the company is primed to provide a broadband distribution alternative to the chimerical interactive television as well, via Microsoft's Media Server system (formerly known as Tiger), which uses racks of off-the-shelf Pentium-based PCs to deliver interactive digital video to the home.

€ V-Chat: This technology allows MSN users to construct avatars and navigate around a variety of 2-D and 3-D spaces. The group is working with some of the world's best known computer graphics experts, including Pixar co-founder Alvy Ray Smith and Cal Tech's Jim Blinn, a flock of whom have landed on the Microsoft payroll.

€ Bruce Artwick Organization: Microsoft purchased Bruce Artwick, developers of Flight Simulator (the popular game that was for many years Microsoft's only "media" product), and will use the underlying technology to build a broad line of simulation games.

€ Digital Backlot, Blender, MSN newsroom: These three state-of-the-art facilities for digital production and design, which support the company's internal media production efforts, cost at least $16 million to build, not including the MSN Newsroom, for which a figure has not been estimated.

€ Research and development: Peter Neupert, vice president of strategic partnerships for the Interactive Media Division, says 15 to 20 percent of Microsoft's R&D team is working on interactive media-related projects. Learning what it takes to build successful interactive brands, Neupert says, "will probably be a growing percentage of R&D on a going-forward basis."

Distribution

€ Windows: By far the dominant operating system for personal computers, Windows has created a standard platform for delivering mediaware products. There are 20 million users of Windows 95, 100 million users of Windows 3.1.

€ The Microsoft Network: 1 million users and growing.

€ UUNet Technologies Inc.: MSN customers get direct access to the Internet via the company's partnership with and equity investment in Internet service provider UUNet.

€ ISDN support: Though not a "deal" per se, Microsoft posted an order form on its Web site that allows Windows 95 users to order high-speed ISDN service from six of the seven regional phone companies, as well as from long distance carriers MCI Communications and Sprint.

€ DirecTV Inc.: In March, Microsoft signed a deal with this direct broadcast satellite service to enable its customers to receive both digital video and new interactive data services through their PCs.

€ MCI/AOL/CompuServe: All these companies have agreed to bundle either Microsoft's Internet Explorer browser or portions of The Microsoft Network (or both) with software for their online services. Prodigy is expected to follow suit shortly.

€ Tele-Communications Inc.: TCI's 20 percent investment in MSN may lead to a distribution deal for MSN with @Home, the cable-modem and Internet services joint venture between TCI and venture capital firm Kleiner Perkins Caufield & Byers. Microsoft and TCI also cooperate on interactive TV ventures, now dormant.

€ Teledesic: Gates is one of the major investors in this company which is developing low-orbit satellite communications technology for inexpensive wireless global communication.